Rates Watch July 2017: Inflation under scrutiny

In a few hours, the South African Reserve Bank (SARB) will announce the Monetary Policy Committee’s (MPC) decision on the Repo Rate. What will it be? Here’s what we think:

Despite what the Cabinet and Public Protector think it should be doing the SARB is, for now, holding true to its mandate of keeping inflation within a target band of 3% to 6%. This means that currently the single most important factor in predicting any future moves in the interest rate is the monthly announcements of Consumer Price Index (CPI) figures.

The latest figures, those for June 2017, show that inflation stands at 5.1%. This is down from May’s figure of 5.4% and sees the third straight month in 2017 of inflation falling within the SARB’s target band. This figure is also the lowest the inflation rate has been since November 2015!

This lower inflation and the fact the local economy is shuddering to a halt would suggest that now is the time to reduce interest rates to lower the cost of lending and thereby stimulate spending and improve economic growth.

And yet the SARB is likely to keep the interest rate steady until September 2017. Why?

More evidence of slowing inflation trend is required

In our current turbulent political climate further shocks to the economy are very likely and these political scandals and government missteps also leave the local economy highly susceptible to changes in markets in the rest of the world. Factors like oil and other commodity prices, the strength of the US Dollar and the drought have all exerted pressure on the inflation rate and means that inflation can fluctuate dramatically from quarter to quarter.

Keeping this in mind the SARB has, for nearly 4 years, been very cautious about adjusting the Repo Rate. I believe that they will require at least another two more months where inflation remains steady or slows before they reduce the interest rate. And this takes us to September’s meeting.

Some areas of interest going forward

Now that I’ve made my prediction for this meeting (and, technically, for September) there are a few interesting areas that will likely determine inflation and SARB policy in the months to come:

The Protector’s Recommendation

The Public Protector and some Cabinet Ministers have reached disturbing conclusions about the role the SARB should play in the economy. While they seemed to have backed down for now, if these conclusions eventually become policy we will see a SARB with a completely different mandate. What this mandate would look like is unknown but it could have a dramatic impact on how changes to the Repo Rate are determined.

For now the Reserve Bank Governor, Lesetja Kganyago, is digging in his heals and making his position clear in both court documents and public statements:

“She [the Public Protector] had no regard for the inevitable and serious impact of her report before releasing it. The report was reckless. The Public Protector’s explanation for it is based on a clear lack of understanding of the constitution. It perpetuates a fundamental misunderstanding of the bank’s powers and functions.”

I’m sure he will be asked for further comment on this matter at the rate announcement and I look forward to hearing what the normally reticent Kganyago says about this particular political development.

Recession and Economic Confidence

Though South Africa is likely to see growth in the 2nd quarter after a technical recession at the beginning of the year, this growth is unlikely to inspire renewed confidence in the economy. This is thanks again to the political scandals rocking the nation and government’s schizophrenic response to crises and scandals. Currently both measures of consumer and business confidence are nearing lows not seen since the Great Recession.

A lack of confidence means increased caution and a reduction in spending wherever possible. Rates of consumer and business spending generally directly impact the economic growth as well as inflation. If spending from these quarters is low, economic recovery will require special government intervention and inflation may decrease. Sustained low growth and slower inflation, as I’ve mentioned, would pressure the SARB to reduce interest rates.

OPEC

Ecuador has recently announced that it will be ramping up oil production making it the first OPEC member to break ranks with current policy. Though it is one of the smaller producers in the cartel this break might lead to a wider split in OPEC and open the door for increased oil supplies. If this occurs and demand cannot absorb this increased supply, the oil price is likely to be significantly reduced.

Oil is used as a direct input in a great many major industries and of course is a key component in energy generation and transportation. Reduction in oil prices will therefore result in a reduction in manufacturing and transport costs in South Africa which in turn could see increased profitability and price reduction of many products.

Increased profitability can improve business confidence and stimulate investment. Reduced prices can result in slower inflation and leave the consumer with more money to spend or invest.

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